Future bonuses of With-profits

[User 1234]

Hi

Would be appreciated if anyone could help me understand the reserving concepts on the with-profits.

Chapter 21 says that " we wish to control the way that our surplus emerges over time, in order to distribute profits over the policy term in the way that policyholders expect"

My question is that:
whether the surplus in the above "surplus emerges" is the surplus before the reserves calculation or after the reserves calculation? I assume the reserves calculation is the gross premium valuation method which does take into account of the future bonuses distribution.
What's the relationship between the surplus emerges and the future bonuses distribution here?

Many thanks in advance!

 

[mugono]

Hi

Before answering the questions you've asked, it may be worth caveating it by saying this is probably outside of the scope for ST2 and more appropriate for an SA2 type question.

1. Surplus emerging and bonus distribution are linked; bonuses are paid from the surplus to emerge. At the point a bonus is declared, reserves increase and the surplus is reduced. Insurers like to control ('smooth') the bonus rates and therefore the way surpluses emerge over time.

2. The calculation of reserves will really depend on whether the insurer is a Peak 1 or Peak 2 basis firm. In the former, use of a GPV is actually imprudent (because benefits only include SA + accrued bonus whilst the gross premium has an implicit allowance for future bonuses) and the reserves would effectively be calculated using a net premium valuation approach - which makes no allowance for future bonuses.

Whilst Peak 2 firms can use a GPV to calculate Peak 1 reserves, such firms also calculate a Peak 2 Balance Sheet which uses a retrospective reserving approach to calculate asset shares.

Hope that helps but again just to stress, this is likely to be outside the scope of ST2.

 

[User 1234]

Hi

Before answering the questions you've asked, it may be worth caveating it by saying this is probably outside of the scope for ST2 and more appropriate for an SA2 type question.

1. Surplus emerging and bonus distribution are linked; bonuses are paid from the surplus to emerge. At the point a bonus is declared, reserves increase and the surplus is reduced. Insurers like to control ('smooth') the bonus rates and therefore the way surpluses emerge over time.

2. The calculation of reserves will really depend on whether the insurer is a Peak 1 or Peak 2 basis firm. In the former, use of a GPV is actually imprudent (because benefits only include SA + accrued bonus whilst the gross premium has an implicit allowance for future bonuses) and the reserves would effectively be calculated using a net premium valuation approach - which makes no allowance for future bonuses.

Whilst Peak 2 firms can use a GPV to calculate Peak 1 reserves, such firms also calculate a Peak 2 Balance Sheet which uses a retrospective reserving approach to calculate asset shares.

Hope that helps but again just to stress, this is likely to be outside the scope of ST2.

Thank you very much mugono

Can I interpretate your points like this?

I control the reserves level (say X) so that the surplus will emerge (say Y) in the future as those expected by PHs. Then because the bonus rate is linked to Y, assume we will distribute 0.99*Y to PHs in the future.
When we calculate the reserve level X, this 0.99*Y are not in the liabilities, right? Only those already declared bonus rate included as the liability in setting this reserve level X, is my understanding correct?

Thank you

 

[mugono]

Thank you very much mugono

Can I interpretate your points like this?

I control the reserves level (say X) so that the surplus will emerge (say Y) in the future as those expected by PHs. Then because the bonus rate is linked to Y, assume we will distribute 0.99*Y to PHs in the future.
When we calculate the reserve level X, this 0.99*Y are not in the liabilities, right? Only those already declared bonus rate included as the liability in setting this reserve level X, is my understanding correct?

Thank you

Hi

1. I wouldn't personally interpret it as 'controlling the reserve level'. Remember, the reserving basis will be signed off and so is predetermined. A better way is to think; bonus -> reserves -> surplus

2. The insurer would carry out a bonus investigation exercise to assess the level and sustainability of the proposed bonus rate considering the surplus and other factors (e.g. PRE, past practice etc). On distributing the bonus the surplus will then reduce.

3. Another important point to make is that the proportion of surplus attributed to policyholders &/or shareholders is typically known at outset. For e.g. in a 90/10 Fund, shareholders are entitled to 1/9 of the cost of bonus or (equivalently) 10% of the distributed surplus. With-profits policyholders receive the balance.

If there are no shareholders (i.e. if we had a Mutual), then any surplus distributed would accrue entirely to with-profits policyholders.

Only the bonus attributed to with-profits policyholders will increase the reserves.

Payments made to shareholders or terminal bonus paid to maturing with-profit policies will be transferred out of the With Profits Fund and any reserves held (against the policies) will be released.

4. The answer to your last question depends.

If a net premium approach has been taken to determine the reserves then the short answer is 'yes' you're correct.

If the insurer had made allowance for future bonus in its time (t-1) valuation for future years (e.g. on Peak 2 or if a GPV is used with an explicit allowance for future bonus) then they would already have allowed for it in the time t liabilities. In this instance you still may get a change to the liabilities (all else equal) if the assumed bonus rate made for the year to time t was different to the rate actually declared.

I am conscious that this is getting complicated and is well beyond what is required for ST2 but I hope this is useful in answering your question.